The impact of a change in interest rates on Irish mortgage holders

The Irish Central Bank publishes data on retail interest rates on a monthly basis and the rate on new mortgage lending receives much media attention, given that it is significantly above the euro average (3.21% in March against 1.81%). Far less attention is paid to the average rate on existing mortgages ( 2.6% against 2.23%) although that is the relevant figure when one is considering the vulnerability of Irish debtors to a rise in interest rates, given the preponderance of floating rate debt.

New borrowers are turning to fixed rate loans in much greater numbers, with over half of new mortgages at fixed rates in the first quarter of 2018, but that is low relative to the euro average ( over 80%) and has little impact on the stock of outstanding debt, which is still heavily weighted to floating rates. For example, some €60bn of the mortgage debt owed to Irish banks in the first quarter was at a floating rate , or 81%, against under €14bn at a fixed rate.

That also means that most mortgage holders have seen a massive fall in monthly payments over the past decade, as the average mortgage rate was 5.3% in mid 2008. The scale of deleveraging since then has also helped to reduce the total simple interest paid monthly on outstanding mortgage debt to Irish lenders, which is currently under €2bn a year against €6.3bn ten years ago. Of course, the corollary is that interest paid on deposits has also fallen substantially, highlighting that any interest rate change is a transfer between saver and borrower.

Most analysts now believe we are at the bottom of the interest rate cycle in the euro area and the ECB will start to raise rates at some point, probably in 2019, although the precise timing is open to debate given the absence of any clear upward momentum in core inflation. How would a rate move affect mortgage holders, if and when it comes?

The average interest rate on existing mortgages which are not fixed is 2.3%, which is biased downward by the proportion of tracker rates ( still over 40% of the total, although falling) where the average rate is just 1.07%. These are linked to the ECB’s main refinancing rate (curently zero) and would not change if the ECB raised its deposit rate ( the most likely first move) although that would push up money market rates and hence standard variable rates ( and lead to higher fixed rates for new borrowers). An increase in the refinancing rate would however be required before all existing floating rates rose .

Although there are only some €75bn of mortgages on the books of Irish lenders the outstanding stock is just over €100bn given securitisation and sales, which implies about €81bn or so would be impacted by a rate change is we assume the same ratio of floating to fixed.The precise effect for each borrower would depend on the maturity of the outstanding debt but if we assume an average 15 years ( most existing mortgages were taken out in the early to mid noughties) a 1% rise would increase payments by just under €0.5bn a year, substantially more than the tax reductions in the 2018 Budget ( €335m).

Of course higher rates would also have an impact on interest rates on deposits accounts , although the precise effect would depend on whether bank margins also changed. However, although total household deposits are also up around €100bn, some 80% are overnight and earning next to nothing leaving total interest paid by Irish banks on household deposists at just €160m a year.

Rate changes generally have a bigger effect on borrowers than savers anyway and so the implication is that Irish household spending would still be significantly affected by a rise in interest rates despite the recent increase in fixed rate borrowing and the deleveraging seen over the past decade.